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Long-Term Budget Forecast
The Patrick Administration is the first Administration in Massachusetts to establish a long-term planning policy to ensure that the state budget is consistent with the principle of fiscal sustainability. According to the Commonwealth’s Long-Term Fiscal Policy Framework, which is posted on www.mass.gov/anf, structural balance is achieved when budgetary spending is based on sustainable levels of revenue, excluding fluctuations that can occur as a result of the economic cycle. When the economy is operating under capacity, the policy benchmark to evaluate structural balance compares the cyclical shortfall in tax revenue to the use of one-time resources included in the budget to offset this shortfall. When the economy is operating over capacity, the policy benchmark compares the cyclical surplus in tax revenue to the deposit of excess resources into the stabilization fund.
The Governor’s proposed FY 2015 budget is in structural balance because the proposed $225 M in net use of one-time resources is significantly lower than the estimated $492 M cyclical shortfall. The $225 M in net use of one-time resources is based on the $334 M figure identified in the budget development write-up, less $110 M in projected stabilization fund deposits. The estimated $492 M cyclical shortfall is based on the long-term revenue forecast that was developed in concert with the consensus tax revenue process as described below.
Measuring Structural Balance
The policy benchmark for structural balance is based on a framework for long-term tax revenue forecasting that was developed by the Executive Office for Administration and Finance (A&F) and the state’s Office of Tax Policy Analysis and uses revenue projections provided by outside economists. The revenue forecast is also used to evaluate other policy benchmarks identified in the Long-Term Fiscal Policy Framework.
The FY 2015 budget achieves structural balance based on an estimated $492 M cyclical shortfall and the use of $225 M in one-time resources, net of deposits into the stabilization fund. The cyclical shortfall represents the difference between the FY 2015 consensus tax revenue estimate of $24.337 B and A&F’s estimate of $24.829 B in tax revenue that the Commonwealth would generate if the economy were at full capacity or “on trend.” The difference between actual/forecasted tax revenue and trend tax revenue is depicted in Figure 1. The development of these estimates is described in more detail in the “Long-Term Revenue Forecast Methodology” section that follows.
The use of $492 M in one-time resources provides a significant margin of safety in comparison to the cyclical shortfall. Further, the Governor’s proposed budget will maintain a balance of $1.201 B in the stabilization fund at the end of FY 2015. The Commonwealth’s appropriated stabilization fund balance for FY 2014 was the fourth highest in the country. The projected stabilization fund balance for year-end FY 2015 will ensure that there are sufficient resources to support the balance of the economic recovery and to provide protection in the event of another economic slowdown. For further discussion of the Stabilization Fund balance, see the Budget Challenges section.
Long-Term Revenue Forecast Methodology
The long-term tax revenue forecast used to estimate the cyclical shortfall is developed in three steps. First, a group of outside economists develop 10-year tax revenue forecasts for the FY 2014-FY 2023 time period. Second, these forecasts include an estimate of the long-run “steady-state” tax revenue growth rate, which reflects the level of tax revenue growth that may be expected in the future when the economy is at full capacity. Third, A&F develops an imputed revenue trend-line for each forecast, which is based on the FY 2023 tax revenue estimate, discounted by the steady-state tax revenue growth rate.
A summary of the external forecasts, A&F’s estimates for long-term tax revenue growth, key assumptions, and calculations are included in Table 1 below. These results show strong revenue growth averaging 5.5% annually during a projected economic recovery between FY 2014 and FY 2016, a steady state growth estimate of 4.0% applied to the period between FY 2017 and FY 2023, and a resulting average growth rate of 4.3% during the full forecast period. The cyclical shortfall reflects the difference between the FY 2015 consensus tax revenue estimate of $24.337 B and $24.829 B, which is the FY 2015 estimate associated with the revenue trend-line calculated using the formula described above and noted in Table 1.
|dollars in millions|
|Tax Revenue Assumptions|
|FY14 Revised Tax Revenue Estimate||$23,200|
|FY15 Consensus Revenue Estimate||$24,337|
|Key Data Points|
|FY16 Tax Revenue Forecast||$25,247||$25,337||$25,890||$25,822|
|FY23 Tax Revenue Forecast||$33,188||$31,655||$36,369||$33,980|
|Compounded Annual Growth Rates (CAGR) (1)|
|Calculation of Estimated Cyclical Shortfall|
|A) FY15 Trend (2)||$24,187||$25,692||$25,766||$24,829|
|B) FY15 Tax Revenue Estimate||$24,337||$24,337||$24,337||$24,337|
|C) FY15 Estimated Cyclical Shortfall (A-B)||$150||-$1,355||-$1,429||-$492|
|MEMO: FY 2014 Cyclical Shortfall||-$674|
|(1) Includes assumed inflation for FY15-FY22 of 2.0%.|
(2) FY15 Trend Tax Revenue = (FY23 Tax Revenue Forecast)/(1+4.0%) (8)
Role in the Long-Term Fiscal Policy Framework
The long-term tax revenue forecast also plays a central role in developing other policy benchmarks that are included in the Commonwealth’s Long-Term Fiscal Policy Framework. The projections for long-term growth in tax revenue and the Massachusetts economy are used to formulate policy benchmarks for the sustainable rate of growth in total spending and health care spending in the budget.
M.G.L. Chapter 224, the Health Care Cost Containment law, requires the Secretary of A&F and the House and Senate Ways & Means Committees to develop an estimate of long-term growth in Massachusetts potential gross state product, to be used by the Health Policy Commission to set the state’s health care cost growth benchmark. Potential gross state product, a measure of the output of the Commonwealth’s economy excluding fluctuations due to the business cycle, is also an estimate of the long-term trend in gross state product.
The alignment of these policy benchmarks and the best practices for long-term planning prescribed by GFOA and GASB are described in more detail in the Commonwealth’s Long-Term Fiscal Policy Framework. The most recent version of the Long-Term Policy Framework was published in January 2014, based on the FY 2014 budget proposal, and is posted on www.mass.gov/anf.
Long-Term Planning and Annual Budget Development
Beginning in FY 2012, the A&F budget staff has consulted the Long-Term Fiscal Policy Framework cited above to establish parameters for agency and program cost growth based on projected annual revenues over medium- and long-term periods. These parameters were used to inform decision-making related to allowable hiring and related program expenditures and served to help A&F develop funding targets for FY 2015 to ensure that state spending ultimately could be sustained by available resources.
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